Weak Earnings Today Could Unleash the Bulls Tomorrow

Be a winner at the expectations game

A Chance to Outsmart Wall Street

So what does this earnings season suggest about the future?

I think Wall Street is trying to set the bar low, and even though valuations are not optimal, pullbacks represent buying opportunities — especially in areas that Wall Street dislikes such as energy, inflation-resistant investments and commodities.

I expect a lot of companies to set forth lowered guidance this year while trying to discourage gleeful thinking about the recovery. That way they can sweep back in with above-board surprises a quarter or two from now, having already built the gains that will occur then on the 19 consecutive weeks of outflows in equity funds happening now.

I also believe Wall Street is all too aware that 2011 was one of the worst years in recent memory. Nearly 60% of all hedge funds lost money, according to preliminary data from the HedgeFund Intelligence Database. Big or small, it didn’t matter.

Noted billionaire hedge fund manager John Paulson — you know, the guy who reaped billions for his “Big Short” against the subprime markets — is reportedly down 51% in one of his biggest funds. You know that’s got to hurt and gives him every motivation to get even.

Not surprisingly, bonuses, thanks to poor performance, were down significantly.

For example, a few years back, many senior Goldman partners reportedly took home $6 million or more. The payout last year was $3 million, according to CNBC.

I know, I know. Cry me a river. I feel the same way.

But here’s the interesting part. Overall compensation as a percentage of revenue is rising. This means revenue is also falling.

Back to Goldman. In 2010, compensation as a percentage of firm revenue was 39.3%. According to CLSA (as reported by CNBC), this figure is now 44%. In other words, revenues have dropped making the same payout a bigger piece of a smaller pie.

How much smaller? That remains to be seen, but in Goldman’s case, firm revenues are expected to have declined by 22%, while profit may have dropped more than 7%. We’ll know what the exact figures are on Jan. 18 when Goldman reports before the opening bell.

Reports also suggest that Morgan Stanley (NYSE:MS) employees may see bonus payout declines of 30 to 40%. Things evidently are so bad that Jefferies Group (NYSE:JEF) employees are threatening to quit if bonuses are not up to snuff.

This is very simple — Wall Street is hurting, which is why better-than-expected results a quarter from now may be precisely the prescription needed to get all that money back into the markets … again.

So view pullbacks with caution, but eye them for what lowered earnings suggest they might be — a chance to outsmart Wall Street at its own game and a chance to buy early.

When everybody else finally gets the message that things are “improving” and piles in, that will be the time to sell and repeat the cycle all over again.

You don’t have to be whipsawed by the temporary swoon it would seem they want to create.